Modern Auditing:

Assurance Services and the Integrity

of Financial Reporting, 8th Edition

William C. Boynton
California Polytechnic State
University at San Luis Obispo
Raymond N. Johnson
Portland State University

Chapter 9 – Audit Risk, Including the Risk of Fraud

Chapter 9 Overview
 Audit Risk – An Overview
• Concept of Audit Risk
– Inverse of reasonable assurance
– If 99% certainty is desired, the audit
risk is 1%

• Professional Judgment and Audit Risk

– Usually audit firm policy
– Comparable from one audit to another
 Fraud Defined
• Acts Resulting in Material Misstatements
– Fraud or Error

– Intentional or Unintentional

• 2 Types of Misstatements Relevant to

Fraud
– Fraudulent Financial Reporting

– Misappropriation of Assets
The Fraud Triangle
 Fraudulent Financial Reporting

• Incentives and Pressures

• Opportunity

• Attitudes and Rationalization

 Misappropriation of Assets
• Incentives and Pressures

• Opportunity

• Rationalization
 Auditing for Fraud
• Risk Assessment Procedures

• Brainstorming Session

• Specific Risks
 Risk Assessment Procedures
• Inquiries of Management

• Consider Unusual or Unexpected

Relationships

• Consider Other Information

 Brainstorming Session
• Allow junior members to benefit from
senior members

• Allow more seasoned personnel a fresh

set of eyes

• Allows audit management to set the

appropriate tone for the audit

• Emphasize possibility of fraud existing in

any audit
 Specific Risks
• Improper Revenue Recognition

• Management Override of Internal

Controls
 Study Break
1. Audit risk is set according to:
A. AICPA guidelines
B. Audit firm policy
C. SEC regulations
D. GAAS

B. Audit firm policy

 Study Break
2. Which of the following is not a
component of the fraud triangle?
A. Adequate training
B. Opportunity
C. Rationalization
D. Incentives

A. Adequate training
 Study Break
3. All of the following are objectives of a
brainstorming session except:
A. Allow management to set the tone
B. Allow for junior members to benefit
from senior members
C. Allow for a fresh outlook on situation
D. Allow for identification of actual
occurrences of fraud

D. Allow for identification of actual

occurrences of fraud
 Audit Risk Model
• 3 Components of Audit Risk
– Inherent Risk
– Control Risk
– Detection Risk

• Illustrating the Model

– AR = IR x CR x DR

• Expanded Audit Risk Model

– AR = IR x CR x AP x TD
Risk Components Matrix
 Assessing the Components of
Audit Risk
• Inherent Risk

• Control Risk

• Detection Risk
 Inherent Risk
• Inherent Risk Defined

• Assessing Inherent Risk

• Identifying Significant Inherent

Risks
 Control Risk
• Control Risk Defined

• Assessing Control Risk

– Planned assessed level of control risk
– Actual assessed level of control risk
 Detection Risk
• Detection Risk Defined

• Assessing Detection Risk

– Planned acceptable level of detection
risk
Interrelationships among Materiality,
Detection Risk, and Substantive Audit
Evidence
Components of Preliminary Audit
Strategies
• Assessed level of inherent risk

• Planned assessed level of control

risk

• Planned assessed level of analytical

procedures risk

• Planned level of tests of details

 Three Basic Preliminary Audit
Strategies
• Response to Lower Inherent Risks

• A Lower Assessed Level of Control

Risk

• A Primary Substantive Approach

Preliminary Audit Strategies and
the Audit Risk Model
Preliminary Audit Strategy
Comparison
 Study Break
4. Which of the following is the
correct audit risk model?
A. AR = IR x CR x DR
B. IR = AR x CR x DR
C. CR = IR x AR x DR
D. DR = CR x IR x AR

A. AR = IR x CR x DR
 Study Break
5. ______ is the risk that a material
misstatement could occur and will not
be prevented or detected by the
entity’s internal controls.
A. Inherent Risk
B. Audit Risk
C. Control Risk
D. Detection Risk

C. Control Risk
 Study Break
6. The components of preliminary audit
strategies include all of the following
except:
A. Assessed level of inherent risk
B. Planned assessed level of control risk
C. Actual assessed level of control risk
D. Planned assessed level of analytical
procedures risk

C. Actual assessed level of control risk